Hank Paulson Has No Regrets

 | Sep 12, 2013 | 2:00 PM EDT
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Five years ago, the Lehman Brothers collapse plunged the world into the type of financial crisis that had not been seen since the Great Depression. What followed was chaos and a domino effect of failures that brought the global economy to its knees. Hank Paulson was U.S. Treasury Secretary at the time and in his book, On the Brink, he said that in response to the crisis, he prayed.

This morning, I watched Hank Paulson on the "Today Show" where he talked about a new documentary made by BloombergBusinessweek, Hank: Five Years From the Brink. When asked by Matt Lauer if he had any regrets about the actions he took -- such as bailing out the banks but leaving home owners and the rest of America to fend for itself -- he said, "No." He explained that the actions were critical to staving off a total collapse of the economy.

I was really taken aback by his response. Here was a guy who had attained the highest level possible in the world of finance -- you can't get much higher than CEO of Goldman Sachs (GS) -- and his response to a liquidity crisis was to inject more capital. You'd think a guy who was in banking, would understand banking.

Banks need capital for one reason and that's to lend. Capital is the only constraint or determinant to bank lending (regulatory issues aside) and in the midst of a global financial meltdown the last thing banks were thinking was how many more new loans they could make.

The principal respondent in any financial crisis should be, first and foremost, the Fed. The Fed has the power to immediately provide liquidity and prevent bank runs and panics. Anyone with half a brain would tell you that should be job one. It was the reason the Fed was created in the first place.

Following the Lehman collapse, the Fed did take action, but it was far too conservative. Bernanke and company provided limited, short-term liquidity and demanded triple-A rated collateral when they should have opened the flood gates. It took months before the Fed realized that it needed to lend in an unlimited, open-ended fashion, accepting all government approved collateral (which is the only thing that banks are allowed to hold on their balance sheets) in order to stop the contagion dead in its tracks. Unfortunately, by the time the Fed realized this, tremendous damage had already been done.

You might say this was not Paulson's mistake. That's true; however, Paulson could have leaned harder on the Fed to take an aggressive stance early on. Maybe he did. Who knows? I was not privy to the conversations, but it seems like that discussion never happened. It was all a "learn as you go" type of thing.

On the other hand, Paulson does deserve blame for giving insolvent banks more capital. If money was needed anywhere, it was in the real economy, where people were suddenly thrust out of work and where businesses' sales were collapsing.

Sustaining the real economy would have meant very little fallout from the banking sector's problems. And, as long as the Fed was providing sufficient liquidity, the nation's payments system would function as usual. Banks that were insolvent could have been closed as they should have been -- and in an orderly fashion without any disruption to anybody. Furthermore, there bonuses wouldn't have been paid out to horribly inept CEOs and bank executives who ran their institutions into the ground. All Americans believe that was outrageous and it was.

So, I'm sorry to say you're wrong, Hank Paulson. The actions you took weren't necessary. They may have been necessary to save the jobs and incomes of your cohorts on Wall Street, but America could have gotten a better deal if you had spent less time praying and more time thinking about the rest of us.

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